Why physical gold is probably worth a lot more than you think.

It would be reasonable to think that the price of gold is determined solely by the supply and demand of the physical product – gold bullion.

But that is not the case.

Most of the “gold” traded each day is paper gold, not physical gold. This paper gold is traded in the form of ETFs, futures and the like. Gold is also leased. And as you probably know, when you want to buy gold bullion you are often given the choice between buying physical gold, allocated gold (which the banks stores on your behalf) and unallocated gold.

Unallocated gold is nothing. It’s simply the promise of gold. And the banks that sell it often don’t have the physical gold in their vaults to deliver on that promise.

Trading in paper gold also opens the door to manipulation and other nefarious goings on.

For example, much of the gold traded as paper doesn’t actually exist in any physical form. Currently there are almost 70 claims on every ounce of gold in the COMEX warehouse, and the same is probably true for the gold available for delivery at the LBMA.

The trading of paper gold is causing many people to wonder if the entire paper gold market is being manipulated to suppress the true value of physical gold bullion.

Tocqueville Gold Fund manager John Hathaway recently noted: “We have an inexplicable discrepancy between what’s happening in physical markets and paper markets. I think there is really something to it. We know that there is now some regulatory interest. The UK’s Financial Conduct Authority has also been looking at precious metals as part of a broader review of financial benchmarks.”

In addition, the German banking regulator Bafin has asked for documents from Deutsche Bank as part of an ongoing investigation into suspected manipulation of benchmark gold prices by banks.

In other words, it’s very likely that there is some skullduggery going on in the paper gold market.

This means that when you look at the day’s spot price of gold, you are looking at a figure that is influenced more by the trading in paper gold than by the supply and demand of physical gold.

My own view is that the paper gold market is being manipulated as a means to suppress the price of gold overall.

When you think about it, there is no compelling reason for real, physical gold prices to have been on a downward trajectory over the last 12 months. It’s not as if the supply of gold has suddenly jumped. It hasn’t. Nor is it true that demand for physical gold has gone down. It hasn’t.

My plan is to keep buying physical gold at the current low prices, and wait for the day when the manipulation of paper gold markets can no longer disguise the true value of the real thing.

In other words, now is a great time to buy and own physical gold. And yes, by that I mean you should buy gold that you can hold in your hand. The real thing.

[This is my second post about the problems that can arise from trading in paper gold. You can read the first post here.]

About the author: DH Kenrick is a student of world economics and a committed gold enthusiast. Follow me on Google+

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